January 18 - Bloomberg (Caroline Salas): "Aramark Corp. sold $1.78 billion
of high-yield, high-risk bonds today to finance its $8.3 billion leveraged
buyout by an investor group including Chairman Joseph Neubauer and private
equity firm Thomas H. Lee Partners LP. The operator of concession stands in
arenas from New York's Shea Stadium to Fenway Park in Boston issued senior
unsecured debt... It dropped a plan to sell subordinated notes, which pay higher
interest rates, because of strong demand for the senior debt..."

January 19 - Bloomberg (Harris Rubinroit): "Apollo Management LP is seeking
$8.98 billion of debt financing to fund its leveraged buyout of Realogy Corp.,
the owner of the Century 21 and Coldwell Banker real-estate brokers, according
to a regulatory filing."

January 14 - Financial Times (Saskia Scholtes and Richard Beales): "The amount
of debt carrying the highest risk of default is rising as a proportion of the
junk bond market, prompting fears the next cycle of corporate failures could
be more severe than the last. In the US, nearly 16 per cent of bonds are rated
CCC or below; up from about 13.5 per cent at the end of 2005, as measured by
the Merrill Lynch high-yield index. High-yield or junk debt is rated below
the BBB bracket, the lowest investment grade rating. Credit ratings of CCC
or below are reserved for junk bonds with the highest risk of default."

January 19 - Bloomberg (Shannon D. Harrington): "The risk of owning corporate
debt is the lowest in at least four years after housing data bolstered confidence
that the worst of the residential real estate slump is over, according to traders
who bet on corporate creditworthiness in the credit-default swap market."

January 18 - Financial Times (David Oakley): "When two of the biggest borrowers
in the credit markets went head to head last week with multi-billion-dollar
bond deals, some bankers expected problems. Could the market digest two $3bn,
10-year issues from KfW, the German development bank, and the European Investment
Bank, the European Union's funding arm, in one sitting? To make matters worse,
two US agencies Fannie Mae and Freddie Mac were also looking to raise $3bn
each in the same 10-year maturity.

Yet, in what can only be described as a remarkable demonstration of the strength
and depth of the credit markets, all four deals ended up heavily subscribed.
In short, the market had absorbed $12bn of 10-year paper from supranational
and agency issuers without breaking into a sweat."

January 14 - Financial Times (David Oakley and Gillian Tett): "The euro
has displaced the US dollar as the world's pre-eminent currency in international
bond markets, having outstripped the dollar-denominated market for the
second year in a row... Outstanding debt issued in the euro was worth the
equivalent of $4,836bn at the end of 2006 compared with $3,892bn for the
dollar, according to International Capital Market Association data. Outstanding
euro-denominated debt accounts for 45 per cent of the global market, compared
with 37 per cent for the dollar... That represents a startling turnabout
from the pattern seen in recent decades, when the US bond market dwarfed
its European rival: as recently as 2002, outstanding euro-denominated issuance
represented just 27 per cent of the global pie, compared with 51 per cent
for the dollar."

Total Money Market Fund Assets, as reported by the Investment Company Institute,
declined $11.3 billion last week to $2.379 Trillion. Money Fund Assets increased
$323 billion over 52 weeks, or 15.7%. Money Fund Assets have expanded
at a 21% rate over the past 20 weeks.

Total Commercial Paper gained $5.0 billion last week to a record $1.995
Trillion. Total CP has increased $313 billion, or 18.6%, over the past 52
weeks. Total CP has expanded at a 21% pace over the past 20 weeks.

Asset-backed Securities (ABS) issuance this week jumped to $20 billion. Year-to-date
total ABS issuance of $28 billion (tallied by JPMorgan) is running ahead of
the $24 billion from comparable 2006.

International reserve assets (excluding gold) - as accumulated by Bloomberg's
Alex Tanzi - were up $804 billion y-o-y (19.5%) to a record $4.935 Trillion.

January 16 - Bloomberg (Nipa Piboontanasawat): "China's foreign-exchange reserves,
the world's largest, topped $1 trillion for the first time, adding pressure
on the government to let the yuan gain faster. Currency assets excluding gold
climbed 30 percent from a year earlier to $1.07 trillion at Dec. 31, the People's
Bank of China said..."

Currency Watch:

January 18 - Financial Times (Richard Beales): "US investors bought a record
volume of foreign assets in November amid fears of a weakening currency, according
to official data... External investment into US corporate bonds also hit a
record, one notable indication that more foreign investors could be shifting
their sights from ultra-safe but low-yielding Treasury bonds into higher-yielding
corporate debt. The record net $39.1bn US investors put into foreign assets
reflected both fears about the dollar and broader trends, according to Rick
MacDonald of ActionEconomics. 'Recent weakness in the dollar may only be exacerbating
already-strong diversification and return-seeking trends,' he said."

The dollar index dipped 0.2% this week to 84.68. On the upside, the Thai baht
gained 2.0%, the Iceland krona 1.1%, the Mexican peso 0.8%, the Australian
dollar 0.8%, and the South African rand 0.7%. On the downside, the Japanese
yen declined 0.7%, the Colombian peso 0.6%, the Paraguay Guarani 0.5%, and
the Kenyan shilling 0.4%.

Commodities Watch:

January 18 - Bloomberg (Chanyaporn Chanjaroen): "Nickel, the only gainer this
year on the London Metal Exchange, rose to a record for a second consecutive
day on speculation that a labor dispute in Canada will cut supply of the metal
used in stainless steel."

January 18 - Bloomberg (Wendy Pugh and Yasumasa Song): "Oil will resume its
march toward $100 a barrel after a 'correction,' said Jim Rogers, who predicted
the start of the commodities rally in 1999. 'I'm just not smart enough to know
how far down it will go and how long it will stay, but I do know that within
the context of the bull market, oil will go over $100...It will go over $150.
Whether that is in 2009 or 2013, I don't have a clue, but I know it's going
to happen.'"

For the week, Gold gained 1.2% to $635.30 and Silver 0.4% to $12.93. Copper
dropped 2.7%. February crude fell 86 cents to $52.02. February Gasoline dropped
2.2%, while February Natural Gas gained 5.3%. For the week, the CRB index was
little changed, while the Goldman Sachs Commodities Index (GSCI) added 0.3%.

Japan Watch:

January 17 - Bloomberg (Jason Clenfield): "Japan's households became the most
pessimistic they've been in more than a year in December after wages fell,
signaling consumers may have tightened their purse strings in the lead-up to
the New Year holiday."

China Watch:

January 18 - Bloomberg (Yanping Li): "China may surpass Germany this year
as the world's second-largest trading country if imports and exports keeping
growing at 20 percent or more a year, said the deputy trade minister."

January 18 - Bloomberg (Josephine Lau): "China may set up a $200 billion investment
agency to help manage the nation's more than $1 trillion of foreign exchange
reserves, Standard Chartered Plc economist Stephen Green said. The new institution
may focus on private equity investments and buying 'strategic' raw materials,
and be modeled on Singapore's state-owned investment company Temasek Holdings
Pte..."

January 16 - Bloomberg (Nipa Piboontanasawat): "China's money supply grew
in December at close to the slowest pace of last year after the central bank
stepped up measures to cool the world's fastest-growing major economy by draining
cash from the financial system. M2, the broadest measure of money supply which
includes cash and all deposits, rose 16.9 percent to 34.6 trillion yuan ($4.4
trillion)..."

January 18 - Bloomberg (Nipa Piboontanasawat): "Hong Kong's jobless rate held
at the lowest in almost six years, fueling wages growth and consumer spending
among the city's 7 million inhabitants. ...Unemployment...was unchanged at
4.4 percent..."

India Watch:

January 19 - Bloomberg (Anil Varma): "Money supply in India expanded at the
fastest pace in more than eight years... The M3 measure of money supply increased
20.4 percent in the period from a year earlier..."

January 19 - Bloomberg (Cherian Thomas): "India's inflation accelerated to
a two-year high in the first week of January as prices of cotton textiles,
fruits and vegetables rose... The key wholesale price inflation rate rose to
6.12 percent..."

January 18 - Bloomberg (Gautam Chakravorthy): "India expects to attract as
much as 500 billion rupees ($11 billion) of investments from private developers
for setting up power plants that aren't tied with long-term power purchase
agreements. India's private developers may add as much as 15,000 megawatts
of capacity under the so-called merchant power plant, as part of the country's
plan to overcome power shortage..."

Asia Boom Watch:

January 17 - Bloomberg (Shamim Adam and Jean Chua): "Singapore's exports shrank
the most in almost five years in December... Non-oil domestic exports fell
14.2 percent from a year earlier..."

Unbalanced Global Economy Watch:

January 16 - Bloomberg (Joshua Fellman): "Hong Kong was named the world's
freest economy for a 13th year by the Heritage Foundation because of its low
taxes, openness to investment and lack of trade tariffs. Singapore was second.
Australia, the U.S., New Zealand, the U.K., Ireland, Luxembourg, Switzerland
and Canada came next on the list..."

January 17 - Bloomberg (Alex Tanzi): "Canadian unit sales of previously owned
homes in 25 major markets rose by 4.9 percent during the month of December...
The number of new listings fell 0.6 percent last month, while the average home
price was $294,190, an increase of 8.1 percent from last year."

January 18 - Bloomberg (Greg Quinn): "The Bank of Canada lowered its 2007
economic growth forecast because of a drop in U.S. demand for automobiles and
building materials. Canada's gross domestic product will expand 2.3 percent
this year, down from an October forecast of 2.5 percent..."

January 18 - Bloomberg (Brian Swint): "Gross [UK] mortgage lending increased
to a record last year as house prices rose, the Council of Mortgage Lenders
said... Gross lending against property rose 20 percent from 2005 to a record...$682
billion. House prices rose around 7 percent last year and home sales increased
14 percent..."

January 19 - MNI: "The UK's measure of broad money, M4, rose in December by
0.9% on the month and 12.8% over the past 12 months... M4 lending rose by...13.4%
on the year."

January 16 - Bloomberg (Peter Woodifield): "The prices of London's most expensive
homes rose last year at the fastest pace since Margaret Thatcher became prime
minister in 1979, as bankers receiving record bonuses competed for a limited
supply of properties. Prices of prime properties in the U.K. capital gained
2.6 percent in December, bringing the increase for the year to 28.6 percent..."

January 17 - Bloomberg (Craig Stirling and Jennifer Ryan): "U.K. unemployment
claims fell more than expected in December to a nine-month low as expansion
in service industries prompted companies to hire more workers."

January 19 - Bloomberg (Jennifer Ryan): "U.K. retail sales rose the most in
18 months in December as faster economic growth spurred shoppers to increase
spending on electrical goods such as flat-screen televisions over the Christmas
period."

January 16 - Bloomberg (Craig Stirling and Jennifer Ryan): "Britain's inflation
rate rose to 3 percent in December, the highest in at least a decade, supporting
the Bank of England's surprise decision to raise borrowing costs last week."

January 18 - Bloomberg (Fergal O'Brien): "Ireland' s opposition parties attacked
Prime Minister Bertie Ahern's government for failing to keep price rises in
check after inflation accelerated to the fastest in four years...Using an Irish
measure, consumer-price growth accelerated to 4.9 percent in December, up from
4.4 percent the previous month..."

January 16 - Bloomberg (Simone Meier): "German investor confidence rose more
than economists expected in January, reaching a six-month high, on the view
that the economy will overcome a sales-tax increase and a global slowdown."

January 18 - Bloomberg (Fred Pals): "Dutch unemployment fell in December to
the lowest in more than three years as the euro region's economic growth encouraged
companies to hire. The jobless rate declined to 5 percent, compared with 5.2
percent in November..."

January 15 - Bloomberg (Simone Meier): "Swiss building permits surged to a
record last year, a sign construction will add to economic growth this year,
Tages-Anzeiger said, citing figures published by Baublatt magazine."

January 16 - Bloomberg (Alistair Holloway): "Finland's annual inflation rate
rose to 2.2 percent in December, the highest level since September 2001, led
by housing costs."

January 18 - Bloomberg (Daryna Krasnolutska): "Ukraine's economy advanced
7% last year, more than double the pace of 2005, as investments surged and
rising steel prices helped boost output and the value of exports."

January 17 - Bloomberg (Michael Heath): "Moscow apartment prices fell for
the first time in more than two years, Kommersant reported... Apartment prices
in the Russian capital more than doubled in the previous 18 months..."

January 17 - Bloomberg (Hans van Leeuwen): "An Australian index of leading
economic indicators increased at the fastest annual pace in almost seven years
in November, signaling growth may accelerate in the Asia-Pacific region's fifth-largest
economy."

January 18 - Bloomberg (Bill Faries): "Argentina's economy expanded 8.6 percent
in November from the same month a year ago, the National Statistics Institute
reported."

January 19 - Bloomberg (Eliana Raszewski): "Argentina's industrial output
climbed 9.0 percent in December from a year earlier, the National Statistics
Institute reported."

Central Banker Watch:

January 18 - Financial Times (Michiyo Nakamoto and David Turner): "The independence
of the Bank of Japan was called into question on Thursday after the central
bank held rates unchanged at 0.25 per cent, apparently under political pressure.
Until Tuesday, the bank had been widely expected to increase rates by a quarter
point to 0.5 per cent. But citing mixed signals over the economy, the Bank's
board voted six to three against a rate rise. The decision sent the yen to
a four-year low..."

Bubble Economy Watch:

University of Michigan Consumer Confidence jumped almost 6 points to the highest
level since January 2004. Initial Unemployment Claims dropped to 290,000 last
week, the low since the week of February 17. The December reading of the Consumer
Price Index was up 2.5% y-o-y. The Producer Price Index was up 1.1% y-o-y.

January 18 - Bloomberg (Tom Randall): "New York City achieved its lowest yearly
unemployment rate since state data collection began in 1976, an average of
5 percent for 2006, said Mayor Michael Bloomberg."

Financial Sphere Bubble Watch:

January 12 - Financial Times (Gillian Tett): "People who watch financial markets
for a living tend to become blasé about big numbers. Nevertheless, the
latest activity in the collateralised debt obligation (CDO) world, could make
anybody blink. According to data released by JPMorgan this week, total issuance
of CDOs - repackaged portfolios of debt securities or debt derivatives - reached
$503bn worldwide last year, 64 per cent up from the year before. Impressive
stuff for an asset class that barely existed a decade ago.

But that understates the growth. For JPMorgan's figures do not include all
the private CDO deals that bankers are apparently engaged in too. Meanwhile,
if you chuck index derivative portfolio numbers into the mix, the zeros get
bigger: extrapolating from trends in the first nine months of last year, total CDO
issuance was probably around $2,800bn last year, a threefold increase over
2005. These startling numbers will certainly not shake the world outside
investment banking. For, as I noted in last week's column, the CDO explosion
is occurring in a relatively opaque part of the financial system, beyond the
sight - let alone control - of ordinary household investors, or politicians."

January 19 - Financial Times (Gillian Tett): "Last week I received an e-mail
that made chilling reading. The author claimed to be a senior banker with strong
feelings about a column I wrote last week, suggesting that the explosion in
structured finance could be exacerbating the current exuberance of the credit
markets, by creating additional leverage. 'Hi Gillian,' the message went. 'I
have been working in the leveraged credit and distressed debt sector for 20
years ... and I have never seen anything quite like what is currently going
on. Market participants have lost all memory of what risk is and are behaving
as if the so-called wall of liquidity will last indefinitely and that volatility
is a thing of the past. 'I don't think there has ever been a time in history
when such a large proportion of the riskiest credit assets have been owned
by such financially weak institutions ... with very limited capacity to withstand
adverse credit events and market downturns. 'I am not sure what is worse, talking
to market players who generally believe that 'this time it's different', or
to more seasoned players who ... privately acknowledge that there is a bubble
waiting to burst but ... hope problems will not arise until after the next
bonus round.' He then relates the case of a typical hedge fund, two times levered.
That looks modest until you realise it is partly backed by fund of funds' money
(which is three times levered) and investing in deeply subordinated tranches
of collateralised debt obligations, which are nine times levered. 'Thus every €1m
of CDO bonds [acquired] is effectively supported by less than €20,000
of end investors' capital - a 2% price decline in the CDO paper wipes out the
capital supporting it.'"

Mortgage Finance Bubble Watch:

January 16 - Bloomberg (Daniel Kruger): "Bill Gross, manager of the world's
biggest bond fund at Pacific Investment Management Co., has pared his Treasury
holdings to the lowest in six months. Gross and a growing number of investors
are reducing Treasury bonds in favor of mortgage-backed securities as expectations
for lower interest rates this year fade."

Real Estate Bubble Watch:

January 17 - Market News International: "The following is the text of the
December Architecture Billings Index released Wednesday by the American Institute
of Architects: 'Following a six point jump in November, the Architecture Billings
Index (ABI) increased even more in December and finished 2006 with its highest
score. The commercial/industrial sector recorded its highest reading in the
history of the survey that originated in 1995, while scores in the institutional
market also showed improvement.'"

January 18 - Bloomberg (Sharon L. Crenson): "Apartment rents likely will rise
in major U.S. markets this year, executives from five U.S. real estate investment
trusts said at a conference in New York. 'We could see a nice run here in the
next few years,' said Tim Naughton, president of...AvalonBay Communities Inc.,
the third largest U.S. apartment landlord... He predicted the company will
raise its average rent by 5 to 6.5 percent in 2007 and 3 to 3.5 percent in
coming years."

M&A and Private-Equity Bubble Watch:

January 18 - Financial Times (Rebecca Bream): "Mergers and acquisitions in
the global gas and electricity sectors rose by 52 per cent to an all-time high
of almost $300bn last year... According to research by PwC, the total value
of deals announced in 2006 was $298.8bn, compared with $196bn in 2005."

Energy Boom and Crude Liquidity Watch:

January 17 - Dow Jones: "Oil and gas drilling in the U.S. hit a 21-year high
in 2006, the American Petroleum Institute said Tuesday, with natural gas exploration
and production the main driver. The API said in a press release that it estimated
49,375 oil wells, natural gas wells and dry holes were completed in 2006."

Fiscal Watch:

After three months of the new fiscal year, federal government receipts are
running 8.2% ahead of the year ago level (to $530.2bn). Individual income tax
receipts are running 8.9% ahead and corporate income taxes 22.5% above the
year ago period. Year-to-date Total Spending is 0.7% ahead of comparable fiscal
2006. By major spending department, spending on National Defense is running
up 9.3%, Social Security 6.2%, Income Security 1.1%, and Medicare 33.7%. Y-t-d
Health was down 1.2% and Interest down 8.6% from last year.

Speculator Watch:

January 18 - Bloomberg (Jenny Strasburg): "Hedge-fund inflows declined 64
percent in the fourth quarter from the record pace of the previous three months
as returns trailed market indexes and investors reacted to the collapse of
Amaranth... Fund managers attracted $15.8 billion in the final three months
of the year, compared with $44.5 billion in the third quarter, Chicago-based
Hedge Fund Research Inc. said... Net deposits were $126.5 billion in the full
year, the most ever and more than double the $46.9 billion raised in 2005."

January 18 - Bloomberg (Otis Bilodeau and David Scheer): "Madeleine Albright,
the former U.S. secretary of state under President Bill Clinton, raised $329
million from a Dutch pension fund that her money-management firm will invest
in emerging markets. Albright Capital Management LLC, an alternative-investment
firm chaired by Albright in Washington, said it will make a 'long-term, multiclass
investment...'"

Financial Sphere Earnings Bubble Watch:

Merrill Lynch reported Q4 Net Earnings of $2.296 billion, up 68% from Q4 2005.
Total Net Revenues were up 27% to $8.609 billion. For the year, Total Net Revenues
were up 33% to $34.659 billion, with Net Earnings up 47% to $7.499 billion. "Global
Markets and Investment Banking (GMI) generated $18.9 billion in net revenues
for the full year 2006, up 37% from 2005, driven by record revenues in both
Global Markets and Investment Banking... GMI's fourth quarter 2006 net revenues
were $5.4 billion, up 55% from the year-ago quarter... Fixed Income, Currencies
and Commodities net revenues of $2.3 billion increased 70%, setting a quarterly
record, driven by every major business line, in particular record revenues
from Credit products, commodities and foreign exchange, as well as a strong
growth from trading interest rate products... Equities Markets net revenues
of $1.8 billion increased 49%, driven by nearly every major business line...
Investment Banking net revenues of $1.3 billion set a quarterly record, up
41%..." The company repurchased 31.1 million shares during the fourth quarter.

At Wells Fargo, Q4 Net Income was up 13% from Q4 2005 to $2.18 billion. During
the fourth quarter, Average Loans expanded at an 11% pace. "Average Commercial
and Commercial Real Estate loans increased $11.5 billion, or 11 percent [y-o-y]...Excluding
real estate 1-4 family first mortgages, average consumer loans increased $19.1
billion, or 16 percent, from a year ago. Average real estate 1-4 family junior
lien mortgage, credit card, and other revolving credit installment loans grew
at double-digit rates from a year ago." For the year, mortgage originations
rose 9% to $398 billion. Non-Accrual Loans and Other Assets" increased to 0.76%
of total loans, up from Q3's 0.68% and Q4 2005's 0.49%. Total Assets were little
changed from the year ago period at $482.0 billion.

Mishkin on Asset Bubbles and Monetary Policy:

Chairman Bernanke testified yesterday before the Senate Budget Committee.
He spoke clearly and forcefully about our nation's dire fiscal predicament,
noting that we are in the "calm before the storm" of a major "fiscal crisis." Untenable
contingent liabilities - most conspicuous today in retiree income and healthcare
benefits - require a major system overhaul. But as much as the Fed and Budget
Committee members may see eye-to-eye the severity of the problem, the environment
is anything but conducive to making tough decisions and taking decisive action.

With federal government receipts growing double-digits during 2006, there
is today little impetus to deal with uncertain deficits somewhere down the
road. This is the case in Washington as well as in Sacramento, Albany and elsewhere.
It is worth noting that federal receipts during fiscal 2007's first quarter
were up 8.2% from comparable 2006, with the federal deficit rapidly shrinking
a third to $80.4 billion (for the quarter). First-quarter receipts were actually
18% ahead of comparable 2005 - only two years ago. And to better ascertain
the current tide of Washington consensus opinion, tune into Larry Kudlow and
hear the clamor of economic miracles, evaporating deficits, and soon to reemerge
budget surpluses. Today, bullish euphoria has the incredible U.S. economic
engine handily coping with the burden of guns and butter - today, tomorrow
and forever. Besides, if at some point the economic expansion were to prove
not quite up to the task, the Bernanke Fed would be right there keen to make
it right.

My frustration with Mr. Bernanke is simply a continuation of the issues I
had with Mr. Greenspan. They talk an especially great game on Capitol Hill.
Both are impressively capable of articulating some of the serious issues facing
our economy - captivating our legislators and media in the process. Wall Street
snickers.

As far as I am concerned, it is disingenuous for chairman Bernanke (as it
was for Greenspan), to propound the necessity of Congress to deal forcefully
with forthcoming problems, while ostentatiously cultivating faith in the capacity
of monetary policy and the markets to cure all ailments. These ills include
future Federal liabilities, the trade and Current Account Deficits and vulnerable
household finances. So, why on earth would Washington fret when the Fed has
for years conditioned Wall Street and global markets not to?

I hope readers will recognize that we today confront one of the Corrosive
Consequences of Inflationism: Complacency and lack of resolve to deal with
critical issues. Confidence in the Fed's capacity to cut rates, manipulate
market behavior, and "reflate"/"reliquefy" has never been as unyielding as
it today. If the power of the Fed was not made clear in the early nineties,
it was in 1998, 1999, and 2000-2003. If the banking system needs recapitalized,
there's no problem. Hedge fund and Y2K scares, the Fed's on the case. If a
collapsing tech Bubble is weighing on growth, simply inflate home prices. If
the corporate bond market suffers from bursting Bubbles, fraud, and problematic
risk-aversion, well, just communicate to the marketplace that it's the Fed's
policy to garnish outsized financial profits on the risk-takers and leveraged
speculators. When the debt load - for individuals, businesses, governments,
speculators - for the entire nation - becomes too onerous, just inflate system
liquidity, asset prices, incomes, earnings and tax receipts.

There are apparently few problems that today's astute monetary policymakers
can't resolve - fiscal, economic or financial. The days of hard decisions,
(personal and national) sacrifice, and saving for a rainy day are, conveniently,
a thing of the past. Activist central banking has somehow - over this protracted
boom - relegated the structure of the real economy, our nation's balance sheet,
and our financial system to peripheral issues.

One of our new Fed governors gave a speech this week that I won't let go unanswered.
Dr. Frederic Mishkin, an academic partisan of Dr. Bernanke's, presented "The
Role of House Prices in Formulating Monetary Policy." It received little media
attention, though it will provide lush fodder for future financial and economic
historians.

Excerpts from Dr. Mishkin's article:

"The issue here is the same one that applies to how central banks should
respond to potential bubbles in asset prices in general: Because subsequent
collapses of these asset prices might be highly damaging to the economy,
as they were in Japan in the 1990s, should the monetary authority try
to prick, or at least slow the growth of, developing bubbles? I view the
answer as no."

"A special role for asset prices in the conduct of monetary policy requires
three key assumptions. First, one must assume that a central bank can
identify a bubble in progress. I find this assumption highly dubious...Indeed,
the view that government officials know better than the markets has been
proved wrong over and over again. If the central bank has no informational
advantage, and if it knows that a bubble has developed, the market will
know this too, and the bubble will burst. Thus, any bubble that could
be identified with certainty by the central bank would be unlikely ever
to develop much further."

"A second assumption needed to justify a special role for asset prices
is that monetary policy cannot appropriately deal with the consequences
of a burst bubble, and so preemptive actions against a bubble are needed.
Asset price crashes can sometimes lead to severe episodes of financial
instability, with the most recent notable example among industrial countries
being that of Japan. In principal, in the event of such a crash, monetary
policy might become less effective in restoring the economy's health. Yet
there are several reasons to believe that this concern about burst bubbles
may be overstated.

"To begin with, the bursting of asset price bubbles often does not lead
to financial instability. In research that I conducted with Eugene
White on fifteen stock market crashes in the twentieth century, we found
that most of the crashes were not associated with any evidence of distress
in financial institutions or the widening of credit spreads that would
indicate heightened concerns about default. The bursting of the recent
stock market bubble in the United States provides one example. The stock
market drop in 2000-01 did not substantially damage the balance sheets
of financial institutions, which were quite healthy before the crash, nor
did it lead to wider credit spreads. At least partly as a result, the recession
that followed the stock market drop was very mild despite some severely
negative shocks to the U.S. economy..."

"There are even stronger reasons to believe that a bursting of a bubble
in house prices is unlikely to produce financial instability. House
prices are far less volatile than stock prices, outright declines after
a run-up are not the norm, and declines that do occur are typically relatively
small. The loan-to-value ratio for residential mortgages is usually substantially
below 1... Hence, declines in home prices are far less likely to cause
losses to financial institutions... Not surprisingly, declines in home
prices generally have not led to financial instability. The financial
instability that many countries experienced in the 1990s, including Japan,
was caused by bad loans that resulted from declines in commercial property
prices and not declines in home prices. In the absence of financial instability,
monetary policy should be effective in countering the effects of a burst
bubble."

"Many have learned the wrong lesson from the Japanese experience. The
problem in Japan was not so much the bursting of the bubble but rather
the policies that followed. The problems in Japan's banking sector
were not resolved, so they continued to get worse well after the bubble
had burst. In addition, with the benefit of hindsight, it seems clear that
the Bank of Japan did not ease monetary policy sufficiently or rapidly
enough in the aftermath of the crisis.

"A lesson that I draw from Japan's experience is that the serious mistake
for a central bank that is confronting a bubble is not failing to stop
it but rather failing to respond fast enough after it has burst. Deflation
in Japan might never have set in had the Bank of Japan responded more rapidly
after the asset price crash, which was substantially weakening demand in
the economy. If deflation had not gotten started, Japan would not
have experienced what has been referred to by economist Irving Fisher as
debt deflation, in which the deflation increased the real indebtedness
of business firms, which in turn further weakened the balance sheets of
the financial sector.

"Another lesson from Japan is that if a burst bubble harms the balance
sheets of the financial sector, the government needs to take immediate
steps to restore the health of the financial system. This should involve
structural improvements in the way banks operate, not bailing out insolvent
institutions. The prolonged problems in the banking sector are a key reason
that the Japanese economy did so poorly after the bubble burst."

Certainly not atypically, Dr. Mishkin's article fails to even use the word "Credit," let
alone analyze the prevailing role of the Credit system in fostering destabilizing
asset Bubbles. Not engendering credibility, the issues of liquidity and speculation
go similarly neglected.

"Home prices, like other asset prices, have important effects on output
and inflation. Home prices affect the economy in two primary ways. First,
when they begin rising, the expectation of further appreciation tends to
become built into the market. That expectation boosts demand for homes, which
stimulates new construction and aggregate demand... Second, higher home prices
increase household wealth, thus stimulating consumer spending, another component
of aggregate demand."

The crucial error in Dr. Mishkin's asset Bubble analysis is to disregard Financial
Sphere Dynamics, certainly including the expansive repercussions historic mortgage
Credit inflation imposed upon U.S. and global economies and global finance,
generally. More insightful analysis would consider - should begin with - the
prominent role of system Credit expansion, liquidity excess and speculative
dynamics. Housing inflation was only one of myriad consequence of the Mortgage
Finance Bubble (including a ballooning Wall Street, leveraged speculator community,
derivatives market and "structure finance" arena). This powerful financial "evolution" unfolded
after years of loose Financial Conditions, only to be inflated to dangerous
extremes with the Fed's post-tech Bubble monetary "reflation." Instead of being
chastened from the gross excesses that fostered myriad Bubbles and busts (MBS/bonds
'94, Mexico, SE Asia, Russia, LTCM, Argentina, tech and telecom), Fed "activism" nurtured
and emboldened an escalation of lending, leveraging, and speculation in housing,
mortgage-related securities and instruments.

The Fed's policy of responding to asset price risk disregards the reality
that behind the serial asset market Bubbles have operated a Credit system and
Pool of Speculative Finance that, by its very nature, inflates only larger,
more powerful, and increasingly destabilizing with each passing year of accommodation.
Over time, as Bubble infrastructure and psychology become more entrenched,
failure to "prick" the Bubble is to further accommodate it. As we have again
witnessed during the past year, there are profound consequences to the Fed's
policy of ignoring Credit excess and resulting asset Bubbles. Moreover, incorporating
into policy the intention of "appropriately dealing with the consequences" of
asset Bubbles openly invites the by now dominating leveraged speculating community
to aggressively position to profit from prospective rate cuts and "reflations."

I am personally a little sick and tired of the cop out nonsense that Bubbles
can't be identified until after the fact. If the focus were on Credit - where
it should and must be -the analysis would become much less nebulous and the
policy task much less ambiguous. When home mortgage debt growth accelerated
from 1998's 8.0% to 1999's 9.4%, the Fed should have been on notice. When 2001's
9.3% growth jumped to 2002's 10.6%, they should have been on guard. When mortgage
Credit then expanded 11.6% in both 2003 and 2004, there was no doubt that a
problematic Bubble in Mortgage Credit had emerged and the Fed should have aggressively
tightened policy. Yet the Fed sat idly by and watched mortgage debt expanded
a further 20% in two years, with resulting unprecedented Current Account Deficits,
leveraged speculation, and global liquidity excess inspiriting speculative
Bubbles in asset, securities and commodities markets across the globe.

Dr. Mishkin's focus is misguided. The crucial question is not whether a bursting
asset Bubble will lead to a severe episode of financial instability. Rather,
the key issue is what impact a vulnerable or faltering asset Bubble has on
the underlying Credit and economic systems. The extent to which stock market
Bubbles have been fueled by underlying speculative leveraging and then exacerbated
system Credit excess will dictate a major influence on the degree of financial
instability one would expect in the event of a crash. At one extreme would
be a stock market boom financed by minimal leveraged speculation within a generally
sound Credit and economic backdrop. At the other end of the spectrum is the
1929 market, with its gross speculative leveraging, acute financial fragility,
and a deeply maladjusted Credit-driven Bubble economy. Somewhere between the
two extremes is Japan in the late-eighties.

As we witnessed here at home, the bursting technology Bubble was met with
surging bond and real estate prices. It triggered little in the way of severe
tumult. Speculative leveraging in bonds and mortgage Credit growth provided
more than ample system Credit and liquidity to sustain that unfolding Credit
Bubble. Indeed, the tech bust and the Fed's response only energized and emboldened
the Credit system and leveraged speculator community. The ballooning Financial
Sphere has been of late further empowered by the prospect of bursting housing
Bubbles and the Fed's foreseeable response. Not unpredictably, unprecedented
Bubble Propagation enveloped the world.

Devastating Credit system crashes - fortunately much rarer events than bursting
asset Bubbles - are the consequence of protracted periods of Credit and speculative
excess. I would argue strongly that the mandatory backdrop demands repeated,
extended, and escalating policymaker intervention and marketplace manipulation.
Only such a constructive environment for prolonged financial excess can create
such acute system fragility - unadulterated markets with functioning self-adjustment
and correction mechanisms and dynamics would not. Regrettably, the Fed's asymmetric
strategy with respect to ignoring asset Bubble while they are inflating and
then reflating aggressively when they falter is tantamount to flagrant market
manipulation.

A Hippocratic Oath is in order: First of all, Federal Reserve monetary policy
must do no severe harm. To live up to such an oath, monetary policy would strive
to avoid fostering Credit and speculative excess, while being prepared to take
all necessary measures to ensure that protracted booms - with their deleterious
effects on the financial and economic structure - not be tolerated. To minimize
the risk of cumulative excesses and imbalances, the policy tool kit should
avoid aggressive rate cuts, marketplace assurances and commitments to respond
to faltering asset markets. Monetary policy should not be used to stimulate
the economy or asset prices - it should not be "activist." Absolutely never
should the Fed use the leveraged speculating community as a reflationary and
liquidity-creating policy mechanism. And never should the Fed pre-commit to
inflationary policies in the event of bursting speculative Bubbles. Drs. Bernanke
and Mishkin's views on asset Bubbles and monetary policy are so dangerously
ludicrous I find it difficult to believe they don't provoke heated debate,
some consternation, and at least a little outrage.